In Defense of the World's Meddlesome Central Banks

There exists a widespread, false impression that Keynesian fiscal policy failed to rally the United States’s battered economy.

This is wrong — the truth is that Keynesian policies were never tried.

The clear lesson that has emerged from these troubled times is that currency flexibility is valuable when dealing with macroeconomic problems. Well, one would hope the lesson is clear.

I have already written about how Britain, Sweden and Argentina have all reaped the rewards of flexibility. Let’s look at the examples of Poland and Iceland, which have benefited recently from currency depreciation.

In a piece published in The New York Times on Dec. 6, the reporter Jack Ewing outlined the advantages Poland has derived from not having adopted the euro (yet): the zloty has fallen about 18 percent against the euro since last year, prices for goods from Poland remain competitive in world markets, and the nation has been isolated from the effects of other countries’ sovereign debt crises.

Iceland is growing again for the first time since its financial system collapsed in 2008 — real gross domestic product grew by 1.2 percent in the July-September quarter.

Of the nations on the periphery of the euro zone where borrowing and spending was excessive before the downturn — Ireland, Iceland, Latvia, Estonia — Iceland had by far the biggest excesses, with a totally ludicrous buildup of debt.

But Iceland allowed private banks to fail and the krona to decline, and through the magic of default and devaluation, it’s actually doing better than the other three nations.

But one of the remarkable things about the crisis of the past three years is that it has actually strengthened the political hand of the hard-money, austerity-imposing orthodoxy — yet the reality is that heterodoxy has worked much better in practice.

Unfortunately, this lesson has been lost on the hard-money crowd in the United States.

Republicans want the Federal Reserve to focus on keeping the dollar strong, and to abandon concerns about unemployment.

Republican congressmen Paul D. Ryan of Wisconsin and Mike Pence of Indiana have repeatedly called for an end to the central bank’s dual mandate to promote both jobs and price stability.

Mr. Pence also said the Fed’s latest quantitative easing program (in which it plans to buy $600 billion in Treasury securities by June) is an example of the central bank’s overstepping its bounds.

“It’s time that the Fed focus solely on price stability and the dollar,” Mr. Pence told The Wall Street Journal on Dec. 7, in reference to the Fed’s new initiative. “QE2 is an example of what happens when the Fed involves itself too much in macroeconomic meddling.”

In other news, Republicans have demanded that doctors consider reintroducing the practice of treating illness by bleeding their patients.

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Paul Krugman joined The New York Times in 1999 as a columnist on the Op-Ed page and continues as a professor of economics and international affairs at Princeton University. He was awarded the Nobel in economic science in 2008.

Mr Krugman is the author or editor of 20 books and more than 200 papers in professional journals and edited volumes, including "The Return of Depression Economics" (2008) and "The Conscience of a Liberal" (2007).
Copyright 2010 The New York Times.